Wednesday, October 22, 2014

Economy: Interest rates have been sinking for 30 years - Causes And Consequences

(Drivebycuriosity) - Interest rates are falling. This is not just a recent phenomena. Interest rates have been sinking for 30 years. The chart above shows the interest rates for 10 year government bonds, the benchmark of the bond market.

What could we learn from the 30 years trend of falling interest rates?

1. In the recent years inflation has disappeared. In the early 1980s the US inflation rate fluctuated between 10% and 14%. The real interest rate (minus inflation) fluctuated around 2%. Creditors demanded a plus of about 10%-points to compensate for inflation, the inflation premium. And the Fed hiked her interest rates massively and kept money tight to break the inflation trend and to destroy inflation expectations.

In the following years inflation rates sank and the interest rates followed because the inflation premium has been shrinking and the Fed could loosen her monetary policy. Today prices rise less than 2% and many are talking already about deflation.

2. The majority is pessimistic. Many expect just an anemic economic growth for the coming years (secular stagnation). The skeptics avoid stocks, which are sensitive to the economic development and risky. Instead they hold their money in government bonds which are considered as safe haven. This trend has driven bond prices upwards and interest rates downwards.

3. Stocks are getting more attractive. Investors can decide whether the buy stocks, which returns are uncertain (especially in the short run) or buy bonds which are much safer. When the interest rate for secure investments like government bonds is say 10%, then it is hard to decide for stocks. Now investors can chose between bonds with an interest rate of around 2% and stocks, which had over the last 100 years an average annual return (including dividends) of around 8%.

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